As Long As Big Banks Rally, Breaking Up Will Be Hard to Do

by Dan Burrows | January 3, 2013 12:17 pm

We’re coming up on the five-year anniversary of the financial crisis, and banks still are too big to fail. In fact, after last year’s amazing share-price gains, it might be harder to break them up than ever.

That would be a mistake not only for the integrity of the global financial system, but shortsighted on the part of big bank investors, too … at least by one analyst’s reckoning.

Well-known bank analyst Mike Mayo of CLSA is no stranger to controversy or making tough calls, which has gained him many enemies and a lot of respect. So his latest broadside against what clearly still is a bloated industry garnered a great deal of attention — even if his prescriptions have little change of being filled.

Mayo wrote in a note to clients this week that the three biggest U.S. banks still have plenty of giant assets ripe for sale or spinoff, and that such moves wouldn’t just help ensure the stability of the banking system, but help stock prices too.

“The largest banks have underperformed not only on returns but also on efficiency, revenue, risk, transparency, reputation and stock price,” Mayo said, according to a report by Bloomberg[4]. “When we ask, a large majority of investors indicate that breakups — divestitures, downsizings and de-mergers — would be good for stock prices.”

There’s no question that even after shedding billions in assets, the three big banks still are too big. Bank of America has sold $60 billion worth of assets since 2010, and it remains a sprawling financial supermarket hobbled by reams of bad debt on the books.

Indeed, the too-big-to-fail banks actually are bigger than before the near-collapse of the financial system. Recall that the crisis led JPMorgan to buy Washington Mutual and Bear Stearns. Bank of America grabbed Merrill Lynch and Countrywide (much to the bank’s regret). Wells Fargo (NYSE:WFC[5]) acquired Wachovia.

Indeed, there actually are fewer, bigger players today, with more risk concentrated in a smaller number of institutions.

But as much as the system would be well-served by making the big three smaller through sales or spinoffs, recent share-price outperformance probably will make it hard for Mayo to find a wide and receptive audience.

After all, the stocks have gone ballistic even as valuations remain at fractional levels. Why mess with the status quo when — on paper at least — it has been so remunerative?

Bank of America, for example, has seen its stock more than double over the last 52 weeks. That clobbers the S&P 500, which is up about 14% over the same span. Yes, the bank’s price-to-book ratio is pathetic, trading at just 0.59, but then that’s also an argument that shares still are attractive even after such a torrid rally.

Citigroup has jumped 45% in the past year and the book value still languishes at 0.65. JPMorgan is up 27%, and its book value stands at just 0.89.

Meanwhile, healthier, more concentrated banks like Wells Fargo and U.S. Bancorp (NYSE:USB[6]) — our two favorite big banks[7] — have put up less impressive gains and yet trade well above book value. They’ve been no slouches, to be sure, but WFC has gained a comparatively tepid 22% in the last year and now trades at a price-to-book of 1.29. USB gained 19% and has a book value of 1.83.

The seemingly still cheap, risk-on, rebound plays have been so good to bank shareholders, it’s hard to imagine they’ll push for big, risky moves like shedding major lines of business.

Why mess with success?

Mayo is almost certainly right in his analysis and prescriptions, but don’t underestimate the power of the status quo when stocks are rallying so fiercely in its favor. Short-term profits have a way of trumping sound strategic thinking.

That’s how we got the financial crisis in the first place.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.